United States Dangerously Close to Debt/GDP Ratio Threshold

February 18, 2011

There is evidence that once a government lets its debt/gross domestic product (GDP) ratio rise more than 90 percent, the economy begins to seriously weaken and government spending starts to spiral out of control as the interest payments on the debt grow faster than the economy. The United States will probably hit the 90 percent threshold within a year (the current level is 68 percent, up from 37 percent in 2008), says Richard W. Rahn, a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

Up to now, foreigners have been willing to buy U.S. debt, but as inflation heats up, domestic and foreign lenders will insist on higher interest to compensate for the expected inflation. The United States has been able to finance its debt with very low interest rates over the past few years, but we are probably close to the endgame with this particular racket.

Greece has already shown the world what happens when the debt/GDP ratio reaches critical levels.

Government services, employment and transfer payments are drastically cut because there is no other choice and the economy goes into the tank.

Britain and a number of other European countries will also likely breach the 90 percent threshold this year, while Japan will be at 200 percent.

Japan has been able to get away with a higher debt/GDP ratio because almost all of the debt is held by the Japanese and Japanese institutions. But this has led to economic stagnation and China just replaced Japan as the world's second largest economy.